by Mark Silva

Treasury Secretary Henry Paulson on Monday will propose a far-reaching streamlining of the federal regulation of U.S. financial markets – involving everything from mortgages and insurance to stocks and commodities markets.

Much of what Paulson will propose requires congressional action, both this year and in the years ahead – with the prospect of any quick action during this election year questionable. But in the short run, the treasury secretary will propose closer coordination among federal regulators.

The plan – a “Blueprint for Financial Regulatory Reform’’ – arrives in the midst of a home mortgage crisis in which spiraling foreclosures have rippled through the economy and already undermined one major Wall Street investment firm, Bear Stearns. But the broader goal of modernizing regulation to keep pace with rapidly changing global financial markets has been under study for more than a year, the Treasury Department says.

The crises of the last several months, and also events in recent weeks, have underscored the importance of a modernized regulatory structure, Treasury believes.

“The United States can no longer rely on the strength of its historical position to retain its preeminence in the global markets,’’ the Treasury Department states in a summary of the blueprint.

Much of what Paulson envisions – such as a merger of the Securities and Exchange Commission with the Commodity Futures Regulatory Commission – requires congressional action. Ultimately, in an “optimal’’ plan which Treasury admits could take several years to enact, Paulson proposes three over-arching regulatory arms of the government focused on financial markets, banks and consumer protection.

Paulson will outline his plan in a speech Monday morning at the Treasury Department. But the planning for all of this started a year ago, after Paulson, former CEO of a Wall Street investment banking firm, was named treasury secretary in October 2006.

"There's a lot of temptation to view this through the lens of what's in the newspapers today,'' said David Nason, Assistant Ttreasury Secretary for Financial Institutions. "But this is a project we've been working on for over a year.''

The Treasury Department has run its ideas past congressional committee chairmen with oversight of the issue, but hasn't taken the matter to congressional leadership yet.

Within the insurance industry alone, Paulson’s proposal faces steep political hurdles. The U.S. has a “state-based insurance regulatory structure,’’ Treasury says, with each state regulating the industry. This inhibits new companies from entering the market, Treasury believes, envisioning one over-arching federal regulator.

The short-term improvement in coordination among existing federal regulators that Paulson proposes can be put in place quickly, through executive orders. But the medium-term proposals – such as merging regulation of the stock and commodity futures markets – will require congressional action.

And the longest-term proposals could require “a couple of administrations’’ to put in place, Treasury allows. This involves a streamlined triumvirate of federal regulatory agencies:

-- A “business conduct regulator,'' focused on consumer protection.

-- A “prudential financial regulator,’’ focused on the safety and soundness of banks.

-- A “market stability regulator,’’ with oversight of investment banks, hedge funds and others in the financial markets, with the ability to move in and take swift action to prevent abuses from destabilizing the market.

“The mission of the Department of the Treasury focuses on promoting economic growth and stability in the United States,’’ the Treasury Department says in its executive summary. “Critical to this mission is a sound and competitive financial services industry grounded in robust consumer protection and stable and innovative markets.’’

The scattered regulatory frameworks of the federal government are traceable to a long history that started with a national banking charter in 1863 and the creation of the Federal Reserve in 1913.

“Historically, the regulatory structure for financial institutions has served the United States well,’’ Treasury says. “Financial markets in the United States have developed into world class centers of capital and have led financial innovation.’’

But to keep pace, Paulson argues, sweeping changes are needed.

In the short run, Paulson proposes using the existing President’s Working Group to promote more communication among regulators and minimize “systemic risk to the financial system.’’ It also will be expanded to include the comptroller of the currency, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision, Treasury says.

And he is recommending that the president appoint a new Mortgage Origination Commission to evaluate the adequacy of each state's system for licensing and regulation of mortgage lenders.
Among the medium-term recommendations that require congressional action: All bank examination for state-chartered banks with federal deposit insurance should be handled by the Federal Reserve, and insurance should be federally regulated.

In the long run, Paulson proposes a Market Stability Regulator, based within the Federal Reserve, a Prudential Financial Regulator with responsibility for banks, and a Business Conduct Regulator.

The majority of this requires congressional action, the Treasury Department acknowledges, recognizing that this will take time – even the course of a couple of administrations. But Paulson will present his blueprint Monday as “a starting point.’’